SBA Sets Rules for Dealing With PPP Loans in M&A TransactionsOctober 8, 2020 – Alerts
New guidance from the Small Business Administration (SBA) sheds light on questions that arise in the context of M&A transactions where one of the companies has secured a potentially forgivable loan through the Paycheck Protection Program (PPP).
Parties to such transactions must be prepared for increased scrutiny during due diligence, transaction timeline delays and certain valuation implications.
Under its longstanding Loan Servicing Guidelines, the SBA must be notified of a change in a borrower’s legal structure if it results in a change to EIN or SSN of any obligor. The Guidelines further provide that lenders may not unilaterally approve any adjustment to or change in the ownership of a borrower, including a change in percentage of ownership, for 12 months after final disbursement on any loan.
In a Procedural Notice issued on October 2, 2020, the SBA clarified what constitutes a “change of ownership” of a PPP borrower and when (and if) SBA approval is needed in connection with the same.
For purposes of the PPP, a “change of ownership” takes place when any of the following occurs:
- the PPP borrower sells or otherwise transfers at least 50 percent of its assets (measured by fair market value), whether in one or more transactions
- a PPP borrower is merged with or into another entity
- at least 20 percent of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity.
Note that in the final scenario, all sales and other transfers occurring since the PPP loan approval must be aggregated to determine if this 20 percent threshold has been met.
The Procedural Notice outlines enumerated situations in which the SBA’s prior approval is needed in conjunction with a change of ownership of a PPP borrower, conditioned on the specific circumstances of the change of ownership, which apply until the loan is paid off in full or forgiven.
To obtain prior approval of the SBA, lenders must submit a request to the appropriate Loan Servicing Center that includes:
- the reason that the PPP borrower cannot fully satisfy the PPP Note
- the details of the requested transaction
- a copy of the executed PPP Note
- any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, seller (if different from the PPP borrower), and buyer
- disclosure of whether the buyer has an existing PPP loan and, if so, the SBA loan number
- a list of all owners of 20 percent or more of the purchasing entity
Note that some lenders are using their own form loan documents (different from the Section 7(a) SBA form loan documents) that do not address and/or provide less stringent change of control restrictions. Regardless of what is contained within these loan documents, the Procedural Notice explicitly provides that, prior to the closing of any change of ownership transaction, the PPP borrower must notify the PPP lender in writing of the contemplated transaction and provide the PPP Lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction.
The Procedural Notice expressly provides that a sale of at least 50 percent of an entity’s assets is considered a change of ownership. Previously, the SBA Loan Servicing Guidelines did not contain a reference to a sale of assets. However, in both pending and future transactions involving a sale of assets, buyers should be cognizant of compliance with the Procedural Notice as well as the underlying loan document, including any limitations on the use of PPP loan funds (e.g., permitted uses, certification of economic necessity, 60% payroll costs, etc.).
Also of note with regard to a sale of assets is that the Procedural Notice affirmatively requires the purchaser to include appropriate language in the purchase or sale agreement regarding the assumption of the PPP borrower’s obligations under the PPP loan.
Outstanding PPP Loans
A critical question with regard to a transaction involving a target with an outstanding PPP loan is whether the loan should be repaid or assumed in connection with the closing. The answer is complicated by the fact that, absent such a transaction, PPP loans may be forgiven and even further complicated by the SBA’s timeline in processing such forgiveness or approval of the change in ownership.
The Procedural Notice expressly provides that there are no restrictions on a change of ownership if, prior to closing the sale or transfer, the PPP borrower has either (1) repaid the PPP note in full or (2) completed the loan forgiveness process in accordance with the PPP requirements and the SBA has remitted the funds to the extent the loan has been forgiven or the PPP borrower repaid the remaining balance on the PPP loan.
Recent SBA guidance on PPP loan forgiveness references a 90-day period for the SBA to approve and disburse the loan forgiveness amount (subject to additional time for further SBA review). This 90-day period is in addition to the 60-day period a lender has to approve a forgiveness application prior to its submission to the SBA – thus collectively bringing the forgiveness turnaround time to a possible 150 days, which may not include the time it takes for the SBA to approve the transaction. Buyers and sellers should take these periods into account when considering the timing for a transaction.
- Conduct thorough diligence on the nature of any change of control restrictions contained within the loan documents and consider whether any restrictions found therein are consistent/inconsistent with SBA change of ownership requirements.
- Assess the borrower’s compliance with the SBA requirements and the terms of the PPP loan (e.g., necessity certificate, use of proceeds, eligibility for funds received, etc.) and conduct heightened scrutiny as needed.
- Consider the timeframe for prior approval from the lender and SBA in combination with the projected transaction timeline.
- Consider how to treat the PPP loan (e.g., is forgiveness sought prior to closing, repayment, etc.) at the onset of proposed transaction.
- Depending on how the PPP loan will be treated, consider supplementing the purchase agreement with more robust representations, warranties and covenants. In addition, consider what (if anything) must be included in the purchase agreement per various SBA requirements.
If you have any questions regarding PPP loans in the context of M&A Transactions, please do not hesitate to contact us.